Monark Monthly March Edition

What a month it has been! As the weather in NYC finally starts looking more like Spring, spirits are up, and the IPO market is back!!? In this article we discuss upcoming public market activity, unique regulatory structures, and the technicalities involved in settling private security transactions on an ATS.

Fintech Optimism is back, for now...

Just this month, announcements from Webull regarding an upcoming SPAC, and eToro regarding a potential IPO add two more companies to the que of fintech's looking to enter public markets this year. Let's be real for a second, the economy is in a tough spot, and without significant rate cuts (which seem increasingly less likely this year) this bubble of exuberance only has so much tailwind before reality sets in. A lot of folks I've talked to give this market rally 12 months before it comes back to reality. An analysis I agree with only because of the unique dynamics around the 2024 election, and the incumbent party's incentive alignment to keep the economy running hot until the next president is decided. This means that if you are looking to raise capital, especially through an IPO, the window to do so is closing quickly. From the world of financial services, Apex Fintech Solutions, eToro and Webull now stand ready, or are at least considering an IPO/SPAC in the next 12 months.

CNBC announced recently that Webull will be seeking to go public via a SPAC merger in the 2nd half of 2024, in a deal that would value the company a $7.3B. A few days earlier, CNBC announced that eToro was eyeing an IPO, after a scrapped SPAC merger in 2021. Apex is also streamlining its business to be prepared for the scrutiny and rules-based order that govern public companies. In November of 2022, Apex sold its crypto business to Bakkt, and the firm recently hired new CFO Chantal Wessels, a former NASDAQ executive. There is definitely optimism in the air, especially in the fintech space, regarding access to capital markets over the next year. As such, we expect to see a flurry of continued activity across the M&A and IPO markets.

Launch of DXYZ

Speaking of public listings, DXYZ is set to list on NYSE in the next few weeks. The Destiny fund, as its pronounced, was started by former Forge Global co-founder Sohail Prasad , and is designed as an index product for private company investing. There are many unique features regarding the structure of this product, but most importantly, the fund is designed to be accessible by investors with a brokerage account, on any platform. While that may not seem exceptional for a public equity, it is exceptional given that this public fund will give investors exposure to the top 100 private companies. So how is this done?

DXYZ will list on NYSE in the next few weeks as an exchange listed, registered closed ended ‘40 act fund. The listing of DXYZ will be a direct listing on NYSE and will actually be a secondary sale of existing securities, purchased by investors through a Reg D offering in 2021. Our good friend Ken McGuire provides a solid analysis of the offering:

"Destiny Tech 100 started as a Reg D offering in January 2021, raising a $100M 3c7 fund from Qualified Purchasers. In May 2022, they filed their initial ’40 Act and ’33 Act registration (which wasn’t declared effective by the SEC until Dec. 2023). ?As of June 2022, they reported a NAV of $66M and about 11 million outstanding shares. (They reported the same number of shares with a $56M NAV as of Dec. 2022) It’s typical that a closed end ’40 Act fund, with a pending ’33 Act registration (as Destiny was in May 2022) to have accepted some accredited investors in order to begin operations. Most unlisted funds would have a small number of seed investors and small number of shares. In July 2023 (while their ’33 Act registration was still pending), Destiny filed under the ’34 Act to register and list their shares for secondary trading. ?Their ‘40/’33 Act registration statement “Plan of Distribution” says, “We intend to keep this prospectus effective until all of the securities have been sold pursuant to this prospectus or Rule 144 under the Securities Act or any other rule of similar effect. The resale securities will be sold only through registered or licensed brokers or dealers if required under applicable state securities laws.” So, strictly speaking, their current offering is a secondary offering NOT a continuous primary offering, which would be prohibited under Reg. M.

One of the questions that has continuously come up regarding registered closed ended funds that trade on a secondary market is the secondary market discount to NAV. Historically, closed ended funds with illiquid underlying assets, have traded at steep discounts in the secondary market, which makes it difficult for the fund manager to continue raising assets in the primary market at NAV. There is no doubt DXYZ will face this challenge, but with the experienced guidance of their CEO Sohail Prasad and COO Ethan Silver , I am optimistic they will find a creative solution to balance this dynamic. We are excited to track the progress of DXYZ as it makes its public debut and starts trading on NYSE, as this fund could lay the groundwork for a new class of registered 40'act funds, to become publicly or privately traded (on an ATS).

Play that song... the one that makes me $$$

March 6th, 2024, brought to market the official launch of JKBX, the investing platform for income producing music assets. Founded by Scott Cohen , the JKBX platform allows individual investors to purchase shares of income producing music assets through Reg A+ offerings. JKBX has a unique offering structure, which is worth discussing. This text from their offering circular describes the structure: "Each Offering is being conducted by the Company as a direct public offering (i.e., without the benefit of the services of an SEC-registered broker dealer) on a “best efforts” basis in a “Tier 2” Regulation A offering by the Company and its associated persons through the web-based JKBX Platform. In conducting this offering, associated persons of the Company, including its Manager, which is acting as a statutory underwriter, intend to rely on the exemption from (securities) broker registration requirements provided in Securities and Exchange Act of 1934 (the “Exchange Act”) Rule 3a4-1."

So, what does this mean? Offerings are sold to the public as direct public offerings, without the use of a firm commitment underwriter. The public markets comparable to this would be a company directly listing on a public exchange, without the use of investment banks acting as intermediary firm commitment underwriters. This model lowers the overhead and compliance cost for the JKBX platform, as managing a broker dealer and committing balance sheet capital for each deal is costly and burdensome. This model is also more conducive towards enabling third party "affiliates" of JKBX (ie. existing music rights holders) to sell portions of their music catalog through the JKBX platform, without JKBX needing to acquire the asset first. Based on the structure of the platform, and the increased scalability of the partnership model, I am guessing this is where JKBX plans to go in terms of sourcing new music assets for the platform. In this set-up, JKBX can run a “best efforts” offering as the issuer of the Reg A+ entity, effectively on behalf of an affiliate seller of a music asset, without making any guarantee that the offering will close or raise capital at all. This is different from the two models that other Reg A+ platforms have used, where either the platform issuing the offering acquires the underlying asset(s) first, before selling them through a Reg A+ offering, or the platform acts as a firm commitment underwriter, committing capital from their balance sheet to ensure the success of an offering. This may be a potential downside of JKBX’s current model, as existing owners of music assets have no way of ensuring that JKBX will facilitate a successful sale of their assets via Reg A+. Affiliates will, however, be able to participate in a testing the waters campaign before going through the SEC Reg A+ registration process, so they will be able to measure some level of interest in the offering before filing. ?

Also of note in the offering circular, JKBX will be leveraging Brassica 's Transfer Agent to fulfill the Reg A+ SEC requirement that issuers must use a Transfer Agent as the registrar of securities, and will utilize Brassica Trust accounts to enable customers to hold cash in their JKBX investment accounts on the platform. As a state-chartered trust company and TA, Brassica can be used as a custodian of cash and securities on behalf of investors, but notably, is unlikely to constitute a "good control location" for broker dealers or alternative trading systems, according to the SEC.

Let's get technical.

If you are not a financial services nerd or a securities lawyer, I suggest you probably end your reading experience here, and enjoy the rest of your Sunday evening. What I mentioned in the line above regarding a "good control location" is an important concept to consider when thinking about developing a secondary trading market for private securities. In the Brassica/JKBX arrangement described above, investors on the JKBX platform are directed to set-up Brassica Trust accounts to act as their custodian when buying securities through the JKBX platform. What this means is that when an investor buys a Reg A+ security on JKBX, they are choosing to custody, or hold, that asset in their Brassica Trust account. For Reg A+ offerings specifically, that security is also held on a ledger managed by Brassica's Transfer Agent. So, if and when, that investor decides they want to sell their Reg A+ security, they will need to do so by submitting an order to an alternative trading system (ATS). If the investor is holding their securities with a state-chartered trust company, they can submit their buy or sell order to the ATS on their own accord. But notably, the ATS will not be able to look to the state-chartered trust company as a "good control location" for that investor's securities. A "good control location" in the context of an ATS, is a qualified custodian that can effectively guarantee the settlement of cash and securities on behalf of their client (investor) and make that representation to the ATS's broker dealer in a compliant way that accounts for risk. The SEC has recently said behind closed doors that a state-chartered trust is unlikely to constitute a "good control location" according to SEA Rule 15c3-3(c)(7) of the Consumer Protection Act. This determination from the SEC is likely due to the lack of federal oversight or net capital requirements imposed on state-chartered trust companies or transfer agents.

Going back to the Brassica/JKBX set-up, an investor that "self-custodies" assets with Brassica Trust can still trade on an ATS, however the ATS will have no compliant way of guaranteeing the settlement of the transaction. This is not a problem if the investor wants to sell to another investor with a Brassica Trust account. For example, if JKBX (in the future) wanted to operate its own closed loop trading environment, where all investors have Brassica accounts, and they all submit orders to an ATS that matches those orders on an agency basis and leaves settlement up to the end investors, Brassica can effectively settle that transaction internally, because; they know all the investors on the JKBX platform. However, if a JKBX investor wanted to sell 10 shares of a Reg A+ security on an ATS to an investor on a different platform, like SoFi for example, the ATS would not be able to compliantly rely on Brassica's electronic attestation of investors cash or securities and will instead be forced to "trust" the actual investors representation that they do indeed own 10 shares of a JKBX asset. This matters, especially for retail investors, because without a system to mitigate transaction risk, trading systems become ineffective at guaranteeing transactions. The Zanbato ATS for instance, touts a 19% historical execution rate on their website, which is a direct result of investors submitting orders to the ATS without the use of a "good control location" to reduce execution risk.

Imagine if only 19% of the orders you submitted on Robinhood executed...

Financial markets are really all about managing risk, and when it comes to the secondary trading of private securities, risk is abundant. In public markets, introducing broker dealers are required to put up deposits to clear trades through a clearing firm, and clearing firms are required to scale their broker dealer's net capital based on the volume of client assets under custody. In this system, each counterparty is regulated to be beholden to the other, resulting in a system of trust that ultimately benefits the end consumer/investors.

When a qualified custodian or “good control location” sits on either side of the trade, an ATS can more effectively guarantee settlement of the transaction, essentially eliminating the risk of bad actors, or one side of the transaction getting cold feet. Without the use of a “good control location,” investors can still transact on an ATS, submitting orders directly to the ATS instead of through a "good control location" intermediary. However, without a good control location, the ATS has no way of guaranteeing the presence of an investor's cash or securities in their accounts, or instructing the clearing counterparties to place a temporary hold on either side of the trade to ensure that a matched order gets settled properly. Now, the ATS itself could also be a good control location and maintain custody of the transacting investors cash and securities itself. However, this model has been limited in the past because it requires all the investors who want to trade a certain security, to create and fund an account with the ATS venue that the security is trading on. Ultimately, the adoption of a centralized ATS venue that can have a higher guarantee of transaction settlement, will require connection to clearing broker dealers and a centralized securities master that all the clearing firms can reference as a central repository, like DTCC in public markets.

Thank you for reading this March edition of the Monark Monthly. Till next time!